Pricing of water and sanitation services is based on a number of factors such as depreciation, operation and maintenance costs, re-investment and profit. The determination of price of the service for a particular segment of the customer profile may vary according to the objectives of the utility, political and social criteria. It is usually better if these criteria are transparent.

Increasing block tariffs (IBT)often called lifeline or social tariffsare often created with the intent of protecting the poor. Under an IBT, the first block of water used (usually 15-25 cubic meters) is provided to a household at a low price, often below the cost of service provision. Households that use a larger volume of water face higher prices per cubic meter. The IBT is based on the assumption that these users tend to be the higher-income households in a community.

The increasing block water tariff (IBT) is a widespread method of pricing water. The pricing system begins with a low initial cost of water that increases after reaching the maximum volume within a block rate. In this paper, the IBT method of pricing is supported on the basis that it will ensure affordable water to the poor, and will also result in better water conservation. The poor will have affordable water because the pricing of the initial volume is less expensive and the effect of steep increases in price, once the initial volume is exceeded, will cut down wastage of water. The paper also covers issues dealing with metered and unmetered water connections and the factual realities of the IBT structure on the poor. There may be inequities in the allocation of costs even when metered water connections are available, as in the case of group homes where determining the actual consumption by each individual in the communal home could be difficult. Generally, these issues are overcome by adopting a point system or an equal allocation of the bill to the various households. Another concern is that sharing water connections could also cause an increased usage of water by the group as a whole, driving up the average price, thereby forcing the poor to pay more for the water they consume. In the event metered water connections are not affordable, the likelihood of the poor purchasing water from their wealthier neighbors increases, often resulting in the poor being overcharged. To close, an insightful analysis of the water system in Kumasi, Ghana is presented. The author argues that the increasing block tariff is an ineffective method of helping the poor gain access to affordable water. In fact, the IBT structure is compelling many poor people in developing countries to pay more for their water supplies than the rich. The solution the author proposes is to create a single-price tariff structure that is far more equitable than the current IBT. (Link)

In practice, increasing block tariffs have a mixed record in helping the poor gain affordable access to water supply services. First, the poorest households in a community generally do not have connections to the water network, and thus cannot take advantage of an IBT. In fact, these households generally purchase water from vendors or re-sellers, who purchase (and thus sell) water in the highest-price block. Second, volumetric tariffs are only relevant where all connections are metered. Third, it is not always the case that higher-income households use more water than the poorparticularly where supply is limited to only a few hours per day. Fourth, it is fairly common for poor households to share water connections. A group of poor families might thus have collective consumption that pushes them into the highest-priced blocks of the IBT, leaving only relatively wealthy households in the lower (subsidized) blocks.

Attempts to protect the poor by limiting the resale price from resalers may not recognise the high costs incurred by the resalers in some cases where tankers have to be used to transport water. Intermediate providers may not be recognised at all and there may be no allowance for bulk sale with the consequence that resalers have no representation, incur high costs and operate outside the accepted system. These negative effects are passed on to the consumer.

Services in low income areas are often provided by informal service providers, private investment or NGO and donor programmes. The setting of water tariffs may not take into account the ownership of this infrastructure and the distribution of responsibility for operation and maintenance.

Cross subsidies are often seen as a means of assisting delivery of affordable services in low income areas but in many cities there may not be enough high income consumers to provide the cross subsidy.

Pricing may be used to generate the revenue for extensions and new connections. This requires viability of the utility and the prioritisation of allocation of this revenue to extend services in low income areas.

Case Example:Block Tariffs and Meters
Southern Sudan

Most utilities in South Asia do not use block tariffs - they can't because they don' have meters so they can't measure the amount of water that people use. Should they provide them? Not necessarily - it depends on whether they have the means to maintain them and maintaining meters when the supply is intermittent, as it is throughout the South Asian region, in very difficult. Turning to Africa, I worked on urban water supply in Southern Sudan for 2 years in the early 1980s. They had meters but almost all were broken. So, they were more of a hindrance than a help. There is no point in getting into discussions of the benefits of block metering unless we can be sure that metering is a viable proposition.

Water (or sanitation) prices should be set taking into account the special situation of the low income community, the ownership of assets, responsibility for operation and maintenance, the level of service and the willingness and ability to pay. Other factors may also be relevant. This suggests strongly that there may be a need for a special tariff setting process to be applied for low-income communities as long as these are readily identifiable and the tariffs can be applied effectively. The pricing policy requires decisions to be made about cost recovery, cross subsidy within the utility area of operations and future investment. This should all be done with full transparency to maximise community and political commitment to the tariffs applied.

Subsidies are driven by the desire to assure that the poor have access to reliable water and sewerage service, which leads to a system of cross-subsidy. The utility charges low-income groups below-average rates, but charges the industrial and commercial uses at above-average rates to make up the difference. While well intended, a cross-subsidy system is difficult to manage. If the utility continually increases prices for industrial and commercial users to make up the shortfall of revenues from households, it may drive its largest customers to terminate their accounts and obtain water supply services through other means (e.g., private borewells). The utility is then faced with the challenge of providing subsidized service to a larger percentage of its remaining customers. In the long run, this situation can threaten the utilitys efforts to move toward financial self-sufficiency, as well as its ability to expand coverage to unserved households.

High connection fees effectively discriminate against the poor. One alternative is to abolish these fees and include in use charges, and the other is to provide long-term financing to facilitate payment.

In many countries subsidy mechanisms independent of the utility is not a feasible option. Such a subsidy requires an elaborate administrative mechanism. In such cases cross-subsidizes might have to be accepted as a second best solution, provided:

- Subsidy should be limited to the poor.
- The level should be based on willingness-to-pay surveys.
- The subsidy should cover at the least all variable costs, including metering, billing and collection.
- The system should be set up in close cooperation between municipal authorities and the utility and be easy to manage and monitor.
- Care should be exercised to determine cross-over price above which some subsidizing users will opt to build their own supplies and stop buying from the utility.

In assessing community demand for improved services, a rigorous willingness-to-pay (or "contingent valuation") study should identify which households have both a willingness and the ability to pay higher prices for improved services. This is not an easy task. Survey respondents must understand the costs and expected benefits of the improved services; how much they and others would be expected to pay for the improved service; and which institutions would be responsible for delivering those services. Because the scenario is hypothetical, respondents may have an incentive to overstate their effective demand (in the hopes of bringing a project to their community), or may understate their demand in an effort to keep prices for the improved services low.

See "Designing a neighborhood deal for urban sewers: A case study of Semarang, Indonesia," by Dale Whittington, Jennifer Davis, Harry Miarsono and Richard Pollard, Journal of Planning Education and Research 19(3): 297-308, 2000.

"Willingness to charge" is also as important as "willingness to pay" when considering tariffs. An immediate shift from low-level tariff rate to a very high-level rate (e.g. more than 100% increase) might not be accepted by decision makers. Therefore, testing willingness to charge is also as important as willingness to pay in some countries. Even where a substantial proportion of households do express effective demand (willingness and ability to pay) for improved services, it is often hard to convince decision makers to raise service prices and, in turn, levels of service. One strategy might be to conduct revealed preference research that documents how much households already pay for the often inadequate services they receive. In some cases, this amount has been shown to equal what would be necessary to provide substantially improved services. Another strategy is to transition gradually to tariffs that cover a substantial proportion of service delivery costs.

Whereas a good deal of research assessing willingness to pay for improved services among households has been carried out, much less is known about the factors that influence willingness to charge among decision makers.

See "Implementing a demand-driven approach to community water supply planning: A case study of Lugazi, Uganda." Whittington, D., J. Davis, and E. McClelland. Water International 23(3): 134.

See "Easing Tariff Increases: Financing the Transition to Cost-Covering Water Tariffs in Guinea." P. Brook and A. Locussol. In Contracting for Public Services: Output-Based Aid and its Applications (2001), P. Brook and S. Smith (eds.). http://rru.worldbank.org/Documents/08ch3.pdf

Objective:

Develop water tariffs for the low-income urban communities which fully and fairly reflect the economic situation of the community, their right to basic services and the cost recovery objectives of the utility.

Actions:

Review the pricing policy in relation to social blocks, lifelines and to support alternative service providers,

Clarify ownership and agree on responsibilities for operation and maintenance, especially the cost implications for infrastructure to be managed by communities,

Determine how cost recovery and cross subsidy will be handled within the utility and between internal sources and external sources of income.

Prioritise, allocate resources from revenue generation to low income communities.

See also: Tariffs and Subsidies: Summary of the Twelfth Meeting of the Urban Think Tank, Mumbai, Maharashtra, April 2001. The report summarizes issues in three Indian cities, reviews water tariffs and subsidy models in Indian cities in general, outlines principles and issues to consider in setting tariffs and subsidies and the weaknesses; highlights the need for dialogue with the poor, and ends with the case for institutional reform to bring greater efficiency and accountability.

See also: Designing Direct Subsidies for the Poor: A Water and Sanitation Case Study
This article illustrates how simulation techniques can be used to inform the design of direct subsidy schemes, ensuring that they are both cost-effective and accurate in reaching the target population. Direct subsidies are an increasingly popular means of making infrastructure services more affordable to the poor. Under the direct subsidy approach, governments pay part of the water bill of poor households that meet certain eligibility criteria. This approach was first used in water sector reforms in Chile in the early 1990s and is an alternative to the traditional method in which governments pay subsidies directly to utilities, often allowing the price of water to fall below economic costs indiscriminately.

See also case example from Chile: Incentive-Based Subsidies: Designing Output-Based Subsidies for Water Consumption
To guarantee adequate and affordable water and sanitation services for vulnerable households, Chile introduced an individual means-tested water consumption subsidy a decade ago. Although the public authorities determine how the subsidy is applied, the mostly private companies deliver the serviceunder a scheme with built-in incentives to ensure cost-effective service delivery by the companies and low wastage by the customers.

See also other lessons from Asia: five recent papers discuss the experience on tariffs and subsidies in the south Asia region, and may provide insights for Africa as well. (pdf downloads)

 Paper 1: Understanding the basics (16 pages)
Water pricing decisions affect several different objectives or goals of policymakers, often in conflicting ways. An efficient tariff will create incentives that ensure, for a given water supply cost, that users obtain the largest possible aggregate benefits. A tariff structure is a set of procedure rules used to determine the conditions of service and the monthly bills for water users in various categories or classes. From an economic efficiency perspective, the problem with a fixed-charge system is that consumers have absolutely no incentive to economize on water use since each additional cubic meter comes free of charge. A uniform volumetric charge has the advantage that it is easy for the consumer to understand, in part because this is how most other commodities are priced. Two-part tariffs have an important role to play in enabling water utilities to simultaneously achieve economic efficiency and cost recovery objectives. It is clear that there is wide variation in tariff setting practices around the world, and that there is no consensus on which tariff structure best balances the objectives of the utility, consumers, and society. Scarce subsidy resources may be more effectively used to reduce the initial cost of new connections, rather than to lower volumetric charges to existing users.

 Paper 2: A scorecard for India (14 pages)
There is a very wide variety of water charging practices across India. However, behind this diversity, there are a number of common underlying characteristics. The charges levied on residential users are less than a tenth of the likely full economic cost. With low tariffs and low effective meter coverage, there are no real economic incentives for Indian consumers to economize on water use. More than 70% of those benefiting from subsidies channeled towards private connections are not poor, while 40% of the poor do not use any public water services are excluded altogether.

 Paper 3: Tariff Structures in Six South Asian Cities (14 pages)
Where an Increasing Block Tariff (IBT) approach exists, the size of the first block varies widely, but in every case is well above what would be considered a true 'lifeline' block to meet basic human needs. Utility managers admitted they either do not have appropriate information to draw conclusions on the effectiveness of IBTs or have not attempted to analyze existing information.

 Paper 4: Do current water subsidies reach the poor? (10 pages)
A high proportion of poor people in South Asia do not have private connections; as a result they are unable to benefit from the heavy subsidization of this service. The average non-poor household receives 44% more subsidy than the average poor household in Kathmandu, Nepal, and 15% more in Bangalore. The absolute value of subsidies to public taps is very small compared with subsidies to private taps, absorbing only 5% to 10% of overall subsidy resources. Barely a quarter of the subsidies provided by State governments and distributed by water utilities in the cities of Bangalore and Kathmandu end up benefiting the poor.

 Paper 5: Can subsidies be better targeted? (10 pages)
Targeting of subsidies can substantially improve the financial position of utilities, with revenues rising between three and fivefold as seen in two case examples. The modified Increasing Block Tariff (IBT) approach barely performs any better than the original one, indicating that it is not possible to improve targeting simply by playing around with the design of the IBT structure. The fact that the accuracy of geopgraphical targeting is just as good as individual targeting is an important finding given that the administration costs are substantially lower. Targeted connection subsidies have leakage rates and errors of exclusion that are barely a quarter of those associated with the status quo IBT.

In Chile, the affordability of water and sanitation services for low-income households is supported by a means-tested, tax-financed consumption subsidy. Although the public authorities determine how subsidies are applied, services are provided predominantly by private companies - under a scheme with built-in incentives to ensure cost-effective service delivery by the companies, and low wastage by customers.
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